GERMANY - The German government is considering penalising private equity firms which it believes serve little or no macroeconomic purpose as part of an upcoming private equity law, according to deputy finance minister Barbara Hendricks.

In an interview with the Financial Times Deutschland, Hendricks said the law would only promote private equity firms who positively affected the German economy.

"The government's goal with the legislation is to strengthen the positive effect the private equity market has on financing small and midsize companies and start-ups," she said.

On the other hand, firms that, in the government's view, served little or no macroeconomic purpose would be penalised, she said.

Advocates for private equity firms warned the government against tightening regulation.

"In general, these investors make a significant contribution in strengthening the German economy. Beyond capital, they bring professionalism, new idea and good contacts with the financial world," noted Dirk Janssen, a lawyer specialising in corporate clients at the Frankfurt law firm.

"Because of this, lawmakers should concentrate on improving investment conditions for private equity houses. Creating special trade rules for them would not only be contraproductive but unnecessary."

While details of the law are still being worked out, Hendricks said an example of the latter case would be if a private equity firm violated German trade laws (HGB). HGB requires a manager of a company to act within that company's interest.

A private equity firm which clearly didn't, according to Hendricks, was Texas Pacific Group. TPG acquired German armature maker Friedrich Grohe in 2004 from another private equity firm.

On TPG's watch, Grohe manufacturing facilities in Germany have been shut down and jobs have been outsourced to countries with lower labour costs. Indeed, the case of Grohe led German vice chancellor Franz Müntefering to compare private equity firms to "locusts" during a speech in April 2005.

In early June, German business daily Handelsblatt reported that the government was mulling a tax on private equity funds domiciled in Germany. The tax would help finance planned tax cuts for German companies, the paper said.

Although the report was later denied by the German finance ministry, it elicited doomsday scenarios from Germany's private equity industry.

Private equity managers said: "If this goes ahead, it would mean the end of private equity in Germany. International pension funds would avoid Germany and private equity houses in Germany would move abroad."

According to German private equity association BVK, its members have €114bn invested in more than 5,500 companies.